Fraud Prevention Tip #15: How to Estimate Your Fraud Losses

For 15 years, I’ve been asking this simple question of financial and audit leaders at live training events.

“How much did your organization lose to
wrongdoing, theft and fraud last fiscal year?”

Answer: Very few leaders even try to estimate their actual losses. Most CFO’s have no idea and they believe it can’t be calculated. They are wrong.

It’s interesting to me. All the talk and articles about the cost of fraud in business yet so little precision or discipline in estimating losses in specific organizations.

Loss statistics get tossed around without critical review or verification, so much so that these flawed numbers become hard facts in the thinking of many financial leaders. “Losses are equivalent to 5% of revenue” is well publicized, and yet inherently flawed. No for-profit business is incurring year over year fraud losses equal to 5% of revenue. Not if they are still in business.

So, how much are you losing?

Here’s exactly how to estimate it. And it’s easy.

Step One. Get a half-dozen of your best thinkers on this topic in a conference room for one hour. Include finance and accounting, internal audit, loss prevention, legal and compliance, your external accountants, and especially a few well-informed operational leaders. Get someone with deep fraud expertise to round out the group. Make sure everyone you invite has a reputation for relevant knowledge and for speaking up. This isn’t time for politically-motivated games. It’s time for honest, open brainstorming about what can and probably is going wrong.

Step Two. Give your brainstorming team this simple task: List the top seven or eight broad areas where you know you have losses. Tell them, “Don’t over think

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this step; go with your gut.” Start by asking:

• How much of our inventory or other asset ‘shrink’ was really diverted?
• What percentage of our employee time charges, travel costs and purchasing card transactions are inflated?
• What portion of the charges from outsiders have been inflated – by vendors, suppliers, contractors, consultants, property managers and other third-parties on whom we rely?
• What portion of our employee benefit costs have been inflated by outside service providers or employees?
• Where have our financial books been cooked even a little bit to meet organization or work group objectives?
• Where have non-financial results been manipulated so that managers and executives can meet their performance, regulatory or public perception goals?
• What sensitive or proprietary data has been taken from us and used to our detriment?
• What fraud exposures unique to our organization or industry have come to life – things like abuse in insurance claims, government program benefits, or services provided by not-for-profits?
• If we knew from a trusted source that fraud was occurring on our watch, what would it be?

Again – and this is very important – limit this initial list of fraud loss areas to seven or eight tops. This is your low-hanging fruit. I use a 5 by 7 inch index card for this exercise. The very small size of the card implicitly limits the length of the list.

Savvy CFOs, accounting and finance managers have taken measures to prevent large-scale fraud and embezzlement. But many organizations still remain dangerously exposed to less grandiose forms of employee theft. The reality in most organizations is that petty crimes of opportunity account for a majority of fraud incidents. Controls are in place to safeguard the family jewels but the less spectacular misappropriations often “fly below the radar” so they are hard to detect and even harder to prevent. As a result, organizations incur small losses (often from multiple perpetrators) over a long period of time … and the running total becomes significant. In fact, studies show that as many as 75% of employee wrong doing never get uncovered … and those that are take place for an average of 18 months before they are stopped.

Step Three. Get the right people to estimate a range of losses for each of these initial seven or eight areas. How much of total inventory shrink is actually due to theft? How much of your construction change orders are inflated during the build up of these charges? What’s the estimate of inflated costs in your employee benefits, time charges and out of pocket reimbursement? The experts or process owners in each area are your best source of this information. Industry associations, benefits consultants, credit card companies, loss prevention and fraud experts, and other sources are helpful as well.

Here’s how to record your results. Complete a Fraud Loss Scorecard like the one in the graphic. Again, don’t overthink or overanalyze your results. If your column totals fall between one percent of revenue (low column) and two percent of revenue (high column), you are on the right track.

Step Four. For one solid year, work every day to cut losses in half in each category on your Fraud Loss Scorecard. This is why we limit the number of areas to seven or eight. To focus attention to the highest payback areas.

Never forget: every dollar saved from fraud losses adds a dollar to income or is available for high value return. Wouldn’t you want to add the equivalent of one percent of revenue to your bottom line in 2015? At zero cost? If I was your CFO, I certainly would!

You see, at the end of the day managing business fraud isn’t only about the triumph of good over evil. It’s also about tracking costs and return on investment.

Whatever your reason for calculating your fraud losses, get started today with this quick and simple approach. Get your leadership team focused. Identify and pick the low-hanging fruit first. Let us know if we can help.

John J. Hall, CPA

John J. Hall, CPA, is an author, speaker and results expert who presents around the world at conventions, corporate meetings and association events. Throughout his 35-year career as a business consultant, corporate executive and professional speaker, John has helped organizations and individuals achieve measurable results. He inspires audience members in corporations, not-for-profit organizations and professional associations to step up, take action and “do what you can.”